Finance 313 Chapter 5 Homework

Jonathan Johnson

000-07-8266

Fin 313

HW#2

Chapter 5

4. You have $5000 to invest for the next year and are considering alternatives:

a). A money market fund with an average maturity of 30 days offering a current yield of 6%

        Your holding period return for the next year on the money market fund depends on what 30-day interest rates will be each month when it is time to roll over maturing securities.

b). A 1-year savings deposit at a bank offering a yield of 9% per year.

        The one-year savings deposit will offer a 7.5% holding period return for the year. If you forecast the rate on money market instruments to rise significantly above the current yield of 6%, then the money market fund might result in a higher HPR for the year.

c). A 20 year US treasury bond offering a yield of 9% per year.

        While the 20-year Government of Canada bond is offering a yield to maturity of 9% per year, (150 basis points higher than the rate on the one-year savings deposit at the bank) you could wind up with a one-year HPR of much less than 7.5% on the bond if long-term interest rates rise during the year. If the Government of Canada bonds yields rise above 9% during the year, then the price of the bond will fall, and the capital loss will wipe out some or all of the 9% return you would have received if bond yields had remained unchanged over the course of the year.

5. Use Figure 5.1 in the next to analyze the effect of the following on the level of real interest rates:

a). Businesses become more pessimistic about the future demand for their products and decide to reduce their capital spending.

        This will cause the demand curve shift to the left thus reducing the equilibrium real interest rate because businesses will reduce their capital spending.  

b). Households are induced to save more because of increased uncertainty about their future Social Security benefits.

        This will shift the supply curve to the right causing a decrease in the equilibrium real rate of interest.

c). The Federal Reserve Board undertakes open-market purchases of U.S. Treasury securities in order to increase the supply of money.

        The Federal Reserve Board undertakes open-market purchase of US Treasury securities in order to increase their money supply.

7). Suppose your expectations regarding the stock prices as follows:

Use equations in 5.11 and 5.12 to compute the mean and standard deviation of the HPR stocks.